2010 AM Exam, #1E. Question. Please help!

During a recent review with Rual, DuBord notes that tax law changes, effective next year, will lower the tax on capital gains to 15% but eliminate the ability to offset income with realized losses. To minimize Rual’s tax liability, DuBord is considering the optimal location (tax- deferred or taxable) for her assets prior to the tax law changes. DuBord and Rual agree to maintain Rual’s current asset allocation. Rual’s investment portfolio and asset location are shown in Exhibit 2.

The answer is to move all equities into the taxable account and all bonds into the tax deferred account. I understand the bonds in the tax deferred account (because they are higher tax and income generating).

BUT, shouldn’t the equities also be in the tax deferred since current capital gains tax is greater than future capital gains tax rates (25% now, 15% in the future). I don’t understand why you would sell all of your equities in the tax deffered account and move them into the taxable account.

Any help is much appreciated. Thanks.

i think due to new tax laws, you will NOT be able to recognize losses to carry forward to offset later gains, starting next year. So you move all equities to taxable accounts and before new law applies, you sell all stocks that have capital loss to offset gains.

I got the quesiton wrong too.

2 reasons to move bonds to TDA:

  1. bonds have a higher cost basis than current market value. Selling the bonds - thus gives you that 50K Tax loss harvest immediately. So this is the rationale for moving bonds to the TDA.

  2. Income from Bonds - taxed at 25% --> higher tax bracket - so move to TDA to defer the taxes.

2 reasons why Stocks should be moved to Taxable account:

  1. Dividends are NOT Taxed.

  2. In case the equities did gain in value in the taxable account and were sold later - they will be taxed in future at a lower capital gains tax rate of 15%.

distributions from the TDA are still taxed at 25% no mateer what kind of returns they are (income, dividens, or cap gains)

taxable account will have CG tax rate of only 15%.

if equities are kept in TDA they will be taxed at 25%, if moved to taxable they will be taxed at 15%

Thanks CP. That’s very helpful.

One last question - with respect to your second point on equities being moved into the taxable account - wouldn’t they also be taxed at the lower captial gains rate of 15% in the TDA if sold in the future at a gain?

Thanks FinNinja. That answers my last question.